Hausmann on the financial crisis and the future of USA’s financial clout

Ricardo Hausmann argues that the financial crisis might empower the US, if it plays its hand well. The US is not the only one suffering from this crisis- capital flows to emerging and developing countries has stopped, threatening to destabilize their growth, financial systems, and balance of payments. He disagrees with Nouriel Roubini, who predicted that the widening US current account deficit would erode other countries’ willing to hold dollars, because the US is still the only remaining super-borrower able to issue billions of dollars in debt at very low rates.

First, the US is already running a large current account deficit, a reflection of the fact that domestic spending is well above output. Using the capacity to borrow just to spend it domestically is going to aggravate this deficit and leave the US with a worsened external balance that will limit growth down the line.

Second, net public debt is rising sharply just as baby boomers will begin to collect their social security cheques, worsening long-run fiscal solvency.

Third, many countries across the world are going to suffer the consequences of the lack of access to finance at a time where the decline in their export earnings would have warranted more borrowing to smooth things out. If unchecked, this will cause their economies to shrink and their imports to decline, hurting US exports just when they are most needed. Under these conditions, there is the risk that countries will shut themselves off from the global economy and impose the financial equivalent of the protectionist Smoot-Hawley Act of 1930 . This can lead to an unravelling of the consensus for globalisation that has characterised the post-cold war era.

Fourth, if the US re-circulates financial resources, by on-lending to well behaved countries that have lost access because of the financial crisis, it would not increase its net debt but instead would make money for the US taxpayer while helping increase demand for US exports.

Fifth, re-exporting capital to the rest of the world would prevent the inconvenient strengthening of the dollar.

Finally, exercising this function would give the US enormous soft power in the world. Countries would have to decide whether they want to play ball with market democracy and benefit from access to the financial resources that the US and others can mobilise, or try to form a separate camp with Russia, Iran or Venezuela just as the rug has been pulled from under them.

Catch-up growth

The IMF's latest Finance & Development magazine focuses on the financial crisis. Good stuff about the impact of financial crisis, its nature, and policy responses.

Nobel laureate Michael Spence chaired the Growth Commission, which recently published a The Growth Report after two years of study on the causes of economic growth. The IMF's new F&D magazine has an interview with Spence and Mohamoud Mohielden (Minister of Investment, Egypt)  about the financial crisis. Spence argues that unclogging credit market should be the first priority of Western  governments and this should be followed by "well-thought-out fiscal stimulus that has a time dimension".

Catch-up growth according to Spence:

We called it catch-up growth because of the global economy's contribution to growth—which we found was an essential element after looking at the dynamics of the successful high-growth cases. It is pretty well understood from trade theory and modern growth theory that global markets are big and a country can grow pretty fast without expanding its market share much—and if it has the terms of trade. But the other part, which is emphasized by Paul Romer and other distinguished leaders in the area of growth theory, is that catch-up growth is really about learning. It's about knowledge transfer. It's expanding your potential output based on what the economy—both the private and public sector sides—comes to have expertise in doing, and that is the catch phrase, no pun intended, for catch-up growth. This is what, we believe, more than anything else enables countries to grow at rates in the 7–10 percent range, and nobody else can do that. You can't do it in isolation and you can't do it as an advanced country with no counterexamples because you have to invent all the technology that moves the production possibility out, whereas developing economies can, at least for a period of time, import it. You have to import it and adapt it so it takes a considerable amount of ingenuity, innovation, and adaptation.

What would The Growth Report have focused on if it were published today? Obviously, financial crisis:

If we wrote the report in late 2008, we would have emphasized the volatility and insurance aspects more, because when they get out of control they produce crises. Also, we already know that such crises are debilitating for progress and growth, and do not adequately support growth policies.

Spence thinks the one key policy ingredient for high growth rate is openness to global economy. Mohielden thinks it is human capital.

In an article relevant to the present global financial crisis, this interview with Robert Shiller is quite interesting. Here is IMF's Chief Economist Olivier Blanchard on the financial crisis and policy responses required during and after the crisis.

Here is an interesting piece from real-world economics review: After 1929 economics changed: Will economists wake up in 2009?

Links of Interest (12/12/2008)

- Bad sign: Ecuador defaults on foreign debt saying it won’t pay “illegitimate” debts owned to “monsters” (Does Ecuador feel like Argentina in 2001 and Mexico in 1994 now?)

- Labor  unrest causes 70 factories to close down in Nepal

- Nepal government rejects USAID’s new programs alleging it of being non-transparent and outside of the budgetary jurisdiction

- The Maoist government’s private armed civilian army (aka YCL) vandalizing a college (see the pic):

 

- Why taxes should be low in developing countries?

There is a good rule in setting taxes: the poorer the country, the lower the tax burden. This is for two reasons. First, poorer countries waste more tax money through corruption. Second, lower tax burdens for businesses lead to more economic activity.

- Lost Decade? or Memorable Hangover?

Cholera outbreak and rosy coffin business in Zimbabwe

This is a very sad news. The NYT reports that there has been an increase in coffin business during the cholera epidemic in Zimbabwe.

A bad statesman, corruption, lust for power, and complete disregard to public’s concerns are turning the bread basket of Africa into a basket case of failed state. The whole economy is in shambles, with stagnating GDP growth rate and inflation rate hovering at 231 million percent. (some say it could be around 8*10^18 percent)

President Robert Mugabe is demagogue! At a time when the development agencies are calling for urgent need to address cholera outbreak in Zimbabwe, Mugabe is arguing that cholera outbreak is contained and the Western countries are using cholera epidemic as a tool to cause war.

"Because of cholera, Mr Brown, Mr Sarkozy and Mr Bush want military intervention," Mr Mugabe said. He added: "Let's tell them that the cholera cause doesn't exist any more."

Shortly after Mr Mugabe spoke, the UN Office for the Co-ordination of Humanitarian Affairs said the toll from the disease had risen slightly overnight to 783 and that 16,403 were believed to have been infected.

The WHO has warned that the total number of cases could reach 60,000 unless the epidemic was stopped.

Child Development Index

Save the Children, UK has released The Child Development Index, the first ever ranking of countries in terms of their performance on child-specific indicators in health, education, and nutrition. Here is a fascinating interactive chart about the index and country performance.

The report focuses on distributional effects of growth on children. It shows that there are still high levels of child poverty and depravation, income levels are a poor indicator of progress in reducing child depravation, children’s wellbeing does not linearly increase with adult’s wellbeing, and there are variations between and within country comparisons.

The three indicators used in the report are: health (under-five mortality rate), nutrition (under-fives who are moderately and severely underweight), and education (primary school-age children who are not enrolled in school). An average of these three indicators is taken by giving equal weight to each of them. A low score represents a low level of child deprivation. A zero score means that all children survive beyond their fifth birthday, all under fives are well-nourished, and all primary school-age children are enrolled in primary school.

According to the report, Japan ranks first with 0.41 score. The other in the top five are Spain, Canada, Italy, Finland, and Iceland. The worse country in terms of child deprivation is Niger (score 85.47). The ten worst countries in terms of child deprivation are all from Sub-Saharan Africa: Niger, Sierra Leone, Somalia, Burkina Faso, Angola, DRC, Chad, Mali, Central African Republic, and Guinea-Bissau. Latin America and the Caribbean performed best with 57% improvement over the three time periods (1990-94, 1995-99, and 2000-06) considered in the report.

The report is critical of slow progress in this front in South Asia (especially India), where high growth rate is not consistent with slacking progress on children poverty and depravation.Nepal’s CDI score is 25.62 and ranks 95 out of 137 countries considered in the ranking. In terms of GDP per capita adjusted ranking, Nepal performed even badly with a ranking of 109. This means that growth in income has not been translated into improvements in child poverty and deprivation!

South Asia has a high level of deprivation, scoring 26.4; this is 3 times worse than East Asia. It is also making slow progress, improving child well-being by just 32% over 1990-2006 (compared to East Asia’s 45% improvement). This is because India (where almost three-quarters of the region’s children live) made the least progress of any country in South Asia; just a 27% improvement. In this region, child nutrition is a substantial obstacle; almost 1 in 2 children is underweight. Malnutrition levels are not being reduced rapidly enough; the region’s enrolment indicator improved by 59% while its nutrition indicator improved by only 14%. Higher levels of economic growth in the region are not widely translating into reduced child deprivation.

Why so much attention on this dimension of poverty? Well, on average each year of schooling increases a person’s wage as an adult by nearly 10% and today’s children are tomorrow’s human capital required for economy.

The report warns that if the current trends in child poverty continues, then there will be more malnourished children in Afria by 2015 than there are today. By 2015, 58 countries will still fall short of meeting the the goal of universal primary education.

HDI vs. CDI:

The United Nations’ Human Development Index (HDI) is similar in concept to our Index, except it mainly uses adult-focused indicators like income and adult literacy.When we compared the ranking of countries in our Child Development Index against the HDI,we noticed substantial differences. Two-thirds of our Index countries are ranked significantly differently (a difference of more than five ranked places) in the 2000–06 CDI than in the current HDI. Several countries are performing much better in terms of the child index than the human index: Malawi,Tanzania and Honduras have moved up in the CDI between 20 and 30 places. And many countries are doing far worse in terms of the child index than the human one, with Oman, Pakistan and the Philippines sliding down in the CDI between 20 and 50 places.

The report suggests policymakers to focus attention on three main dimensions of child poverty and depravation: prioritizing child nutrition, promoting equitable development,and supporting women’s education and empowerment.

Some stats:

• 9.2 million children die every year before they turn 5 yrs old
• 97% of all child deaths occur in 68 countries
• 143 million children are malnourished
• 1/4 of all the children in the world are underweight
• 1/3 of all children have stunted growth
• 75 million primary school-age children are not enrolled in school

An international perspective about the MDGs

New book (fodder for winter break!) - Reaching the MDGs: An International Perspective

Recommendation by the authors to reach MDGs by 2015:

identify win-win policy options that can help raise productivity and reduce inequality at the same time

accompany the implementation of policy innovations with data collection that can assist policy monitoring

invest in impact evaluation strategies, as prioritisation may vary by country or region

apply extra effort in focusing monitoring on a small subset of indicators

further research the synergies between the various MDGs

identify poor households in terms of multiple poverty dimensions

balance growth-oriented investment with social service spending that directly addresses the non-income dimensions of poverty

in the case of donor countries, comply with their funding commitments and provide recipient countries with funding predictability

 

(via Eldis Poverty)

Impact of global financial crisis on the Nepali economy

That’s the title of my new op-ed published in a new news portal launched toady in Nepal. More on the new media house and news portal here.

Impact of global financial crisis on the Nepali economy

How will this crisis affect a small, landlocked country like Nepal? It will not directly affect the Nepali financial system, nor put strains on monetary policy, as Nepal is largely insulated from the toxic assets of big investment like in the West. However, it will indirectly affect economic growth, revenue collection, and development initiatives carried out by Non Government Organizations (NGOs). Potential monetary imbalance may arise from changes in Indian monetary policies and the exchange rate of NRs vs. INRs.

The economy could feel the impact of global financial crisis through four different routes- a slowing down in inflow remittances, a recessionary tourism sector, decline in aid, and a demand-deficient manufacturing sector. While a slowing of the first three components will affect poverty reduction and development initiatives, the decline in global demand for Nepali-manufactured products will put direct downward pressure on growth rate. The rate is expected to hover around 5% during 2009.

A global economic meltdown will decrease demand for products made in India, where a majority of low-skilled Nepali laborers work. Meanwhile, a slowing down of the construction and service sectors in the Middle East, the other major source of remittances, and in countries such as South Korea, Malaysia, and Japan, will result in lowering demand for Nepali labor abroad. Put simply, fewer workers leaving the country in days ahead will decrease remittances inflow in a number of ways. This could affect the rate of progress made in poverty alleviation and potentially lower domestic demand, as households will be more hesitant to spend money due to declining income.

Remittances, which currently account for 19% of the Gross Domestic Product (GDP), have been extending the economy a lifeline for almost a decade. It is chiefly due to these remittances that the balance of payments is still in surplus despite a huge balance of trade deficit. Remittances have furthermore helped decrease the poverty rate from 42 percent in 1995/96, to 31 percent in 2003/04. More than 34% of households receive remittances, an increase of more than 80% since 1994/95. Over one million Nepalis working abroad send money directly to their families, a portion of which is generally used to meet regular expenditures, and the remainder saved in domestic financial institutions.

A global slow-down and recession in Western economies will also affect the Nepali service industry, which contributed 50.9% of GDP in 2007. Global recovery is not expected any time soon as the Western financial crisis steadily worsens. This means potential tourists are likely to postpone or cancel travel plans. By working with the government and launching promotional packages, Hotel Association of Nepal (HAN) is hoping to entice about a million tourists in 2010. If the global economic slow-down continues past 2010, this dream seems unachievable

Meanwhile, the aid industry will also not be spared from the crisis. NGOs operating in Nepal receive funding from corporate donors, governments and large foundations in the West. The global slow-down will limit this funding, forcing the organizations to scale back development initiatives. This will have a negative impact on the fight against poverty and other development challenges. The manufacturing sector will also suffer. Export to major Western countries is expected to slow in the coming years. The Confederation of Nepalese Industries (CNI) recently estimated that the manufacturing sector would incur a loss of $256.16 million as a result of the global economic slow-down.

An extended and original version of the article is available here.

Snapshot of the new news portal: